Pro Perspectives 1/25/23

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January 25, 2023
 
The price action in stocks should have the bears very worried. 
 
Regardless of where the futures markets have traded overnight,  for the past four sessions, when the cash market opens, stocks have gone straight up (chart below).  
What does it mean?

 
The speculator types can dominate futures trading overnight, and at times can set the tone for the way the cash market trades on the day.  In this case, when the "real money" comes into the market (i.e. large institutional money managers), there is clearly appetite to put cash to work.
 
This comes as the world's stock market proxy (S&P 500) has technically broken out (a bullish breakout).  And it comes as we head into next weekend's Fed meeting. 
 
Of course, Fed policy has been the primary burden on the stock market for the past year.  And that burden might be lifted as soon as next Wednesday, with any indication that they are ready to pause the rate cycle.
 
On the latter, the Bank of Canada may have kicked off this new "pause" phase on global monetary policy this morning.
 
Here's what they said:  "If economic developments evolve broadly in line with the forecast we published today, we expect to hold the policy rate at its current level while we assess the impact of the cumulative 425 basis point increase in our policy rate.  We have raised rates rapidly, and now it's time to pause and assess whether monetary policy is sufficiently restrictive to bring inflation back to the 2% target." 

Pro Perspectives 1/24/23

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January 24, 2023
 
Coming into the year, the consensus view for Q4 earnings season was for a 3.2% decline in S&P 500 earnings.
 
The noise in the media was for something much worse (an "earnings bust").  
 
So far, it isn't the blood bath some were expecting.
 
Keep in mind, this comes in a quarter where the economy was likely growing at a better than 3% annual clip.   
 
Also keep in mind, when given the opportunity (with low expectations already built in), corporate America will put all the bad news they can muster on the table, lowering the expectations bar, so that they can set up for positive surprises in future quarters.   

 
That said, we kicked off earnings with the big four banks.  They all set aside capital, adding to what is already a war chest of reserves from the quarters that followed the pandemic lockdowns.   If we add these new Q4 allowances for potential loan losses back, all four of the biggest four banks in the country would have beat earnings estimates, AND improved on the earnings from the same period a year ago.  
 
Bottom line:  It's not a sputtering economy with a demand problem. It's a hot economy, thanks to the deluge of money still floating around, where demand is being throttled by the Fed.  What happens when the Fed backs off? 
 
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Pro Perspectives 1/2323

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January 23, 2023
 
We ended last week looking at this chart …
As you can see, this big trendline in the S&P broke today.
 
A similar trendline in the Nasdaq also broke today.
 
The Dow is above the 200-day moving average, and has been for two months.
 
German stocks broke out of the downtrend a little more than two months ago, and now trade 27% higher (from the lows).
 
British stocks are just a little more than 1% off all-time highs.
 
And as we discussed Friday, Chinese stocks are on the move.  Several catalysts have lined up to drive both domestic and global growth, not the least of which is the end of zero covid policy. 
 
So, all of this, and we are a little more than a week away from an event that has been the sentiment spoiler for much of the past year:  another Fed meeting.
 
Since August, the Fed has made a clear effort, through rate hikes, guidance and threats, to tighten financial conditions.  And yet, the Chicago Fed's National Financial Conditions Index (which measures credit, risk and leverage) is just about where it was when the Fed started raising interest rates.  
 
And if you look at a chart of that index (below), you can see what today's level looks like (far right on the chart), relative to the levels in each of the past seven recessions (indicated by the shaded gray areas).  It's not close to looking like recession. 
Now, despite this setup above, the Fed has worked hard to quash any bubbling up of optimism along the path of the past year.
 
They’ve left nothing on the table.   
 
With all of the bullets they’ve fired, it’s hard to imagine how, at this stage, they could negatively surprise markets next week. 
 
They’ve already told us they want to take the Fed Funds rate another 75-100 basis points higher.  They’ve already dialed down their forecast on economic growth to almost nothing (just 0.5% for 2023).   And they’ve told us they think unemployment is going a percentage point higher.  
 
This, as the very inflation they profess to still be fighting most recently printed in negative territory (i.e. deflation from November to December).  The monthly change in prices over the past seven months averages to just 0.12%.  Annualize that, and inflation has been running below the Fed’s 2% inflation target, for many months now.
 
And we’ll head into next week’s meeting with a GDP report, due this Thursday, that will show an economy that grew at a better than 3% annual rate last quarter. 
 
Bottom line:  The Fed will have a very difficult time coming up with something to damage the momentum in markets.  
 
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Pro Perspectives 1/20/23

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January 20, 2023
 
As we end the week, let's take a look at a few charts.
 
First, here's a look at U.S. stocks …
As you can see this big technical trendline we've been watching, still holds.  This is the trend that defines the bear market of last year.  Interestingly, the last two tests of this line coincided with two very important inflation reports.
 
Stocks failed into this line both times, despite the improving inflation picture from both reports.  Why?  It was largely because the Fed went on the offensive immediately (against potentially easing financial conditions).  They were  quick to combat improving sentiment in markets with more threats of higher interest rates.
 
That said, it looks like we will get another test of the trendline in stocks next week. 
 
Meanwhile, if we look at the bond market, the big trendline here has broken (in yields) …
For the better part of the past thirteen years, we've been used to seeing yields plunge/bonds soar on the view of (more) emergency monetary policy coming and/or heightened fear (i.e. safe haven flows into bonds).
 
In the current case, after the 60/40 bond portfolio had the worst year on record, the world is pouring money into bonds to start the year, both to capture the best yield in a long time, and also seeking bond price appreciation.  Bond returns and bond sales are off to the best start to a year ever. 
 
Finally, let's take a look at Chinese stocks …
It was in June of last year that things appeared to be opening up in China, and the economy was in an upswing,  and then by July another wave of infections hit, and the government went back to lockdowns.  You can see in the chart above, the ETF that tracks large cap Chinese stocks (symbol FXI) broke to new lows.  
 
Now we have a number of catalysts working in favor of Chinese stocks, including a number of monetary and fiscal stimulus measures over the past several months.  Then the government scrapped its zero covid policy.  And now it appears they are relaxing restrictions on their real estate market.  Stocks are moving. 
 
On China, as we discussed in my Jan 5 note, "a faster rate of change in foreign interest rates, relative to the U.S., means money will move out of the dollar (weaker dollar).
 
For those searching the world for value, with a catalyst, it can be found in emerging market Asia.  If history is our guide, this is likely where we will see the best stock market performance in the world over the next few years." 
 
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Pro Perspectives 1/19/23

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January 19, 2023
 
If we look back over the past 13 years, investors have had plenty to worry about.  
 
Let's step through the post-Great Financial Crisis period. 
 
Following the global government and central bank rescue efforts and stimulus of 2009, Wall Street told us the era of developed world dominance had come to an end, and that the future of investing was in China.  By 2010, it was obvious that China couldn't thrive while the Western world economies were suffering.  The slowdown in China became the worry for markets.
 
In 2011, during a debt ceiling fight on Capitol Hill, Standard and Poor downgraded the U.S. credit rating, cutting it from AAA.
 
Next up, Europe: Europe was on the brink of a sovereign debt default and collapse of the euro, over the course of a few years.  
 
Then we had Ukraine/Russia 1.0.  Then the Chinese stock market crashed, and China shocked global markets with a surprise currency devaluation.  
 
Then oil prices crashed.  
 
Then Trump entered, and was immediately impeached.  
 
Then the world was shaken by the U.S./China trade war.  Then we had a global pandemic.  Then we had rampant, 40-year high inflation.  And then we had Ukraine/Russia 2.0.  
 
Along the way, stocks climbed the wall of worry.  Including dividends, the S&P 500 delivered eleven wining years, averaging 17.6% — and two losing years, averaging down 11.3%.  Fourteen years later, and throughout all of the chaos listed above, every dollar in the stock market is worth $3.48. 
 
Here we are in 2023, and again, there is plenty to worry about, including another debt ceiling saga.  Why does a "wall of worry" tend to be constructive for bull markets?  Because it breeds positive surprise. 
 
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Pro Perspectives 1/18/23

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January 18, 2023
 
The Bank of Japan held its ground overnight.  They kept key short term rates negative.  And they maintained the cap on their 10-year government bond yield at half a percent.
 
So, Japan continues with pedal-to-the-metal stimulative policy, even as inflation is running at four decade highs.  And even as the rest of the world is well into tightening campaigns. 
 
What did the the BOJ governor have to say?  
 
He said he wouldn't hesitate to ease further if necessary.
 
He said it's important to support the economy.
 
And he said it's important to encourage companies to raise wages.
 
These are three diametrically opposite initiatives of that of the rest of the Western world. 
 
The Fed has threatened to tighten more (err on the side of too tight), has explicitly worked against the economy, and has outright wanted to suppress wage gains.  
 
For context, it's important to remember that Japan has been attempting to reverse nearly three decades of deflation.  Former Prime Minister Abe was elected 11 years ago on the promise of ending the economic malaise and deflationary vortex that had troubled Japan for more than two decades. And he hand-selected a governor of the Bank of Japan (Haruhiko Kuroda) to execute an all out war on deflation.
 
So Kuroda is not going to let up (not on his watch).  After dealing with three decades of deflation, he's going to let the economy run hot.  And he's focused on preserving standard of living (against inflation) by encouraging wage growth.  Meanwhile, hot nominal growth solves a lot of problems.  It's a recipe for inflating away the government debt burden (Debt/GDP goes down).
 
It's a logical game plan.  And it's a game plan the Fed and Treasury appeared to be executing in the early response to the pandemic shut-down.  They erred on the side of being over-aggressive.  They printed and they spent, and they restored economic output inside of a year.  They stoked hot nominal growth, which inflates away the debt burden. 
 
But then the political pendulum shifted, and restoring economic prosperity was abandoned for the global climate agenda.
 
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Pro Perspectives 1/17/23

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January 17, 2023
 
On Friday we talked about the signal gold may be sending.
 
Perhaps this will be the year that consequences are levied for $10 trillion-plus of deficit spending, globally, in response to the pandemic.  
 
Of course, that was adding to what was already an unsustainable global sovereign debt situation.  
 
It's a bubble.  
 
And as we've discussed often here in my daily notes, it seems to be building toward a global debt restructuring, and a new currency regime (likely coming in the form of central bank backed digital currencies).
 
If that indeed is the ultimate destination, will it be slow moving, or will it be event driven (a shock event)?
 
With the above in mind, on Friday we looked at Japan as a hot-spot and potential catalyst for the onset of another crisis in global sovereign debt markets.
 
Global interest rates have been rising.  Japan, having the world's largest debt load, relative to the size of its economy, is most vulnerable to rising interest rates.  That's why the Bank of Japan has held rates near zero, despite the rest of the Western world ratcheting rates 250 to 450 basis points higher.
 
The rapid growth in that interest rate spread promotes the flight of capital OUT of Japan, and in search of higher yield.  And the pain of that dynamic is only compounded by speculative capital trading the direction of those capital flows (i.e. out of Japanese assets, out of the yen).  
 
Add to this, with inflation rising to four-decade highs in Japan, the Japanese government bond (JGB) market would be in sharp decline IF it were left to market forces.  
 
But as we know, the Bank of Japan is in control of the government bond market.  It is keeping a lid on JGB yields, through its "yield curve control" program.  The question is: Are they losing control? 
 
Will the selling pressure in JGBs become so great, in combination with the broader market forces of inflation and higher global interest rates, that the Bank of Japan is forced to back off, at some point, and let its bond market go (i.e. let market forces determine the appropriate interest rate)?
 
The Bank of Japan is meeting now, and will decide on monetary policy tonight (Wednesday afternoon in Japan).  This may not be a graceful exit of emergency polices by the Bank of Japan. 
 
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Pro Perspectives 1/13/23

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January 13, 2023
 
We end the week with stocks on the highs, and (still) trading into this big trend line that represents the bear market of last year. 
We had a positive catalyst for stocks on Thursday, with the weak inflation report.  And we had another positive catalyst today, as the big banks kicked off Q4 earnings season with solid performance.
 
Three of the four big banks beat earnings estimates.  But each also set aside more reserves for potential loan losses — to the tune of $2.25 billion (between the four).  And that is added to what is already a war chest of capital that remains in the coffers from the worst of the pandemic period.  
 
If we add back these new Q4 allowances for potential loan losses, all four of the biggest four banks in the country would have beat earnings estimates, AND improved on the earnings from the same period a year ago.  
 
So, as we discussed yesterday, Wall Street has been wrong on Q4 economic growth, and based on the bank reports today, it’s a safe bet that they have undershot on earnings growth in Q4.
 
Let’s take a look at gold …
Gold has been on a tear, up nearly 6% on the year, already.  It closed on the highs today, and at the highest level since April of last year.  It’s only $150 from the record highs.
 
Is gold finally signaling that the unsustainable global sovereign debt bubble is going to be pricked this year?  Maybe. 
 
And it may come from Japan.  Japan has been fighting the deflationary vortex for the better part of the past thirty years.  They’ve printed yen, and inflated debt, with no inflationary consequences — until now.
 
In fact, the post-covid global inflationary environment may prove to have been the perfect storm for stoking inflation in Japan. Inflation is running at a four decade high, and the Bank of Japan looks like it may lose control of the Japanese government bond market (JGBs). 
The Bank of Japan has been intervening, daily, trying to contain the yield on 10-year JGBs to 50 basis points (part of their "yield curve control" program).  
 
The question is:  If they back off of this band, altogether, how low will the value of JGBs fall, and how fast? 
 
I suspect that's why gold is heading for record highs.   
 
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Pro Perspectives 1/12/23

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January 12, 2023
 
We’ve spent the week talking about the setup for a weak inflation report, and a bullish breakout in stocks. 
 
​We got the former this morning.  The latter is yet to be determined. 
 
As expected, there were well-placed Fed speakers, lined up, following this morning’s inflation data, ready to counter the optimism about the prospects of a less restrictive Fed, with promises that they would not be less restrictive.  
 
But the credibility of the Fed’s tough talk is rapidly deteriorating, as the monthly change in prices, over the past seven months, averages to just 0.12%.  Annualize that, and inflation has been running below the Fed’s 2% inflation target, for many months now.
 
The focus now turns to earnings and the health of the economy.  
 
How much damage has the Fed done to consumer and business behaviors?
 
Earnings season will kick off tomorrow, with Q4 reports from all of the big banks.  Head of the largest bank, Jamie Dimon, said earlier in the week that the consumer is still strong, balance sheets are in good shape, and “they are spending more than pre-covid.”
 
Those comments give us nice clues on what the banks should say tomorrow. 
 
With this in mind, let’s take a look at how the economy performed during this Q4 period.
 
As you can see in the above, the Atlanta Fed's model (the green line) has Q4 GDP growth at better than 4% annualized.  Importantly, you can see in the same chart that Wall Street's projection (the blue line) has been much lower, all along the way.
 
With that in mind, if we look at Q4 earnings expectations, it should be no surprise that the Wall Street analyst community has spent the past several months dialing down earnings expectations for Q4.  They've gone from expecting 3.5% earnings growth (back in September), to the expectation of a 4.1% decline now.
 
So, we'll see in the coming weeks, if the street was as wrong on earnings as they appear to have been on Q4 growth.
 
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Pro Perspectives 1/11/23

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January 11, 2023
 
We head into tomorrow's huge inflation report, with stocks closing on the 200-day moving average (the purple line in the chart below).  And trading just below this trendline (yellow) that represents the bear market of 2022.

A weak inflation number tomorrow, would be a clear catalyst for a bullish technical break out in stocks.
 
Let's take a look at the CPI index …
You can see in this chart, inflation over the past six months on this headline index has already leveled off.  The rate-of-change in prices, inflation, has clearly been curtailed.  That's good!
 
But even if tomorrow is a seventh consecutive month of mild monthly inflation, when measured against the low base of twelve months ago, it's still a big number (and will be for months ahead).   In fact, even if the November to December change in prices within this index, were zero, the year-over-year inflation would still be 6.8% inflation.  This the "base effect" that the Fed once used, back in 2021, to dismiss inflation as "transitory."
 
Bottom line, what matters is the monthly change in prices. With that, let's look at some inputs into CPI that we know.  Will it be weak? 
 
First, gas prices:  The Energy Information Administration (EIA) does a weekly survey of gas stations across the country.  Those survey results show a decline in gas prices by about 8% in December (and down 35% since June). Transportation carries almost a 1/5th weighting in the CPI calculation.
 
Used Cars:  The Manheim used car price index was UP less than 1% in December.  That breaks a sixth months of consecutive price declines.  Overall used car prices were down 15% from the beginning of the year.
 
New Car prices:  Cox Automotive says average new car prices were up 1.9% in December..
 
Rents:  The Apartment List Rent Report showed a fourth consecutive monthly decline in rents, down 0.8%.
 
House prices:  Redfin.com says the median house price was up 1.3% from November to December.  That's down 8% from the June peak.  What about mortgage rates?  Mortgage rates finished December about 17 basis points higher than the month prior.
 
And we know from the ISM services report, released earlier this week, services prices were down in December.
 
Food is the only big component remaining:  This has been a hot area of the inflation report this year, finally showing some signs of cooling in November. As a proxy, the FAO Food Price Index, which measures global food prices, fell in December for a ninth consecutive month.
 
So, the price data look mixed in December.  But as we know, the government data tends to be stale.  If we look back at end of November data, from these same sources listed above, prices were broadly declining.      
 
With all of this in mind, by no coincidence, the Fed has three officials (speakers) on the calendar before midday tomorrow. 
 
We should expect them to continue doing what they've been doing:  Combatting optimism, with threats of higher rates at the economy and financial markets, in order to keep a lid on confidence. 
 
As we discussed yesterday, with the 10-year yield at 3.55% heading into tomorrow's number, the bond market isn't in agreement with the Fed's narrative.  That gives courage to stock investors.